By William S. Barrett, Esq.
Expanding the partnership ranks in a dental practice is a lot like getting married. Plenty have cold feet before taking the plunge. Some jump into it too quickly and are disappointed when their partners aren’t everything they’d hoped for. The successful ones take their time, look for the right fit, are committed to the practice for the long haul, and are willing to work through any differences encountered along the way.
These eight key issues should be considered by both the partner in the established dental practice, as well as the associate ready to make the jump to partner.
Issue 1: Culture fit and philosophy
Ideally, partnerships are long-term. When the arrangement is good, life is good. When partnerships go bad, they can feel like never-ending root canals. Before anything else, associates need to think deeply about whether they share the same professional and business philosophies as the senior dentist. It’s important to be like-minded about important issues, such as how and when to invest in the practice. The practice’s culture, and whether the associate feels comfortable with it, also needs to be considered. Practice ownership is not for everyone. Some associates have no desire to subject themselves and their families to the financial risk and the management responsibilities that come with practice ownership.
Issue 2: Do due diligence
Before buying into a practice, thoroughly review the documents provided by the senior dentist. Don’t be shy about asking questions concerning all aspects of the practice — financial statements and patient records, personnel records, financial records, tax returns, bank statements, accounting functions, marketing programs, supply vendor records, leases, important contracts, and more. Understand the practice’s expenses during your due diligence, and raise concerns if there are issues. Beware of existing partners who are dangerously free with a dollar. They might run an outstanding practice, but they have a tendency to run cash-poor because they have to have every new gadget and diagnostic tool, regardless of whether that equipment generates the revenue to justify it.
With the help of a CPA, analyze the practice’s tax returns, financial statements, and bank statements. Perform a trend analysis, not only of revenues, but also of the patient count. Carefully review the equipment list. Is the equipment up-to-date, or will funds need to be earmarked for new equipment? Is the equipment connected to a lease obligation? The bottom line is, if you are considering buying into the senior dentist’s practice, you need to thoroughly analyze the inner workings of the practice.
Issue 3: The purchase price
Establishing and agreeing upon the value of the practice when buying in is a major hurdle. It is essential to get a fair market independent appraisal of the practice at the outset in order to avoid frustration and disappointment with the outcome. It is common for buyers and sellers to get emotionally involved in the negotiations. However, both would do well to remember that open communication is essential. After all, both parties will be working side-by-side for many years, and a positive introduction of a new partner can make all the difference between the success or failure of the partnership and thus, the practice itself in the long term. Any lingering animosity on either side over contentious negotiation or a less-than-fair deal can negate the benefits of a flourishing partnership.
Important factors generally considered in valuing a practice are 1) its location, 2) the ability to effectively transfer goodwill to a future buyer, 3) years in existence, and the stability of the practice, 4) demand for the practice’s services, 5) the quality of the staff, and 6) the practice’s revenue growth.
Issue 4: Structuring the buy-in and financing options
Structuring the buy-in, including how it will be financed, is one of the most important parts of the partnership arrangement. How the buy-in is financed is a key determinant of the new partner’s long-term cash flow and, ultimately, his or her success. In most cases, the incoming partner will pay a portion of the initial purchase price, typically 10% to 20%, upfront and pay the remainder over time pursuant to the terms of the promissory note. Another option for the parties to consider is a “sweat equity” structured buy-in. Sweat equity refers to the junior dentist’s contribution to the practice in the form of effort. In most instances, the junior dentist will be given an initial ownership interest at the closing (10%, for example), with the opportunity to receive additional ownership interests over a period of time (such as five years).
There is more than one way to structure and affect a successful buy-in. Much depends on the special circumstances of each buy-in. Obviously, the purchase price and the payment structure will have tax consequences for both parties that will need to be considered and addressed.
Issue 5: The purchase agreement
The purchase agreement will need to address liabilities arising from the acts of other dentists in the practice that occurred prior to the actual buy-in (the closing date), and general liabilities of the practice (such as debt, real property and equipment leases). In addition, the purchase agreement must address whether the junior dentist, who is buying in, will be required to guarantee any existing loans or leases.
The purchase agreement will also likely include the following terms — percentage of ownership interest, purchase price, loan contingencies, due diligence, and representations of the senior dentist (concerning pending litigation, power and authority of the seller, taxes, compliance with laws and regulations, etc.).
Issue 6: The “partnership” agreement
The terms of the partnership agreement address how the practice will be managed and who will be responsible for the practice’s day-to-day operation. In most cases, the senior dentist will want to retain responsibility for the day-to-day management. However, the partnership agreement can call for the new partner’s input on “major decisions” identified in the agreement. The agreement should also address exit strategy issues that are set forth in the “buy-sell” section of the agreement. The parties need to establish under what circumstances a co-owner (or his or her estate, if deceased) would be forced to sell ownership interest, and on what terms. As part of the process, the partnership agreement must identify a formula to value the ownership interest, and provide payment terms that will either require the owners to buy insurance to fund a purchase (such as life insurance or lump sum buy-out disability insurance) or specify the length of time for payment (such as 60 months) and the rate at which the unpaid balance will accrue interest.
Issue 7: Employment agreements
Each of the dentists should have written employment agreements describing how each dentist will be compensated and what benefits they are to receive. A practice’s compensation structure is the most important part of its culture and one of the hardest things to get right and keep right. The employment agreements set forth how each dentist can be terminated for “cause” (such as a conviction of any felony, suspension or termination of the dentist’s professional license, etc.). The agreements also set forth the restrictive covenants (non-competition, non-solicitation, and confidentiality) that each dentist must comply with for an agreed upon time (such as three to five years) in the event their employment with the practice is terminated.
Issue 8: Restrictive covenants
One issue to be addressed in the negotiation process is whether a new owner should be subject to a non-competition/non-solicitation covenant if he or she leaves the practice. The short answer is a definitive “yes.” Many co-owners view the restrictive covenant negatively, but a restrictive covenant protects co-owners equally from a departing co-owner competing with the practice. Restrictive covenants that arise as part of a partnership agreement are typically deemed enforceable if reasonable in scope (the geographic radius of the restriction) and in duration (the term of the restriction, typically three years or less).
The buy-in transaction has a natural flow and process. The dentists should focus on practicing and letting their advisors advise them. Associates considering partnership buy-in have to decide what’s best for them, not what’s best for their lawyer or accountant. Each deal and practice is unique, so be careful when comparing buy-in deals at different dental practices. It is important to engage a dental transactional attorney and a dental CPA who are familiar with the issues to guide potential partners through this important process.
Sinking Your Teeth into an Associateship Arrangement
Co-Ownership -- Minimizing Your Tax Risks
William Barrett is a partner at Mandelbaum Salsburg (www.msgld.com), and leads the firm’s medical/dental practice. He is recognized nationally as an authority in dental law, with unique expertise in dental and dental specialty practice transactions, practice sales and purchases, associate buy-ins, and financing options and workouts. Mr. Barrett can be reached at 973-736-4600 or [email protected].